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Blueprint for a British
Investment Bank
Robert Skidelsky
Centre for Global Studies
Felix Martin
Thames River Capital
Christian Westerlind Wigstrom
Centre for Global Studies
Blueprint for a British
Investment Bank
Robert Skidelsky
Centre for Global Studies
Felix Martin
Thames River Capital
Christian Westerlind Wigstrom
Centre for Global Studies
The Office of National Statistics recently reported that the
British economy has grown by only 0.5% over the past year:
private sector demand is depressed by deleveraging and
uncertainty, while public sector demand is constrained by
the government’s austerity strategy. Britain needs to
rebalance its economy away from reliance on credit-fuelled
private consumption and towards investment and exports.
And the public has lost confidence in banking as a socially
useful activity.
A British Investment Bank (BIB) presents a potential solution
to these problems. Robert Skidelsky at the Centre for Global
Studies and Felix Martin at Thames River Capital invited
leading figures from the British private and public sectors, as
well as representatives of the European and Nordic
Investment Banks, to discuss the merits of this solution at a
one day conference in Westminster on the 2 November 2011.
This publication is inspired by these discussions.
2
ISBN: 978-0-9546430-7-2
© The Centre for Global Studies
Introduction to the British Investment
Bank Conference
Thank you for making the time to come to this colloquium on
a British Investment Bank (BIB). This is a good time to hold such
a conference. It is clear that national recovery has stalled. The
British economy has grown less than 1% in the last 12 months.
National income per head – the only measure which matters for
the British people – has actually fallen. Given this dismal
situation, it is hardly surprising that more and more people
have been asking: where is growth to come from? The
Government is committed to removing 2% of GDP a year from
the economy over the course of this parliament. The Bank of
England has just announced a new £75bn round of quantitative
easing, but even the Governor, Mervyn King, does not believe
that this modest programme will be able to kick start growth.
At most, and subject to many uncertainties, it may do
something to offset GDP decline. Not the least frightening fact
about the Bank of England’s latest assessment of the effects of
QE is that the Bank does not actually know how money created
by the Bank is transmitted to the economy.
We may expect some relief from the exchange rate. But our
major trade partners in Europe and elsewhere are not growing
either. It is in this context that what I call Plan C - Plan A being
the now exploded theory of ‘expansionary fiscal contraction’
and Plan B being a further bout of QE – becomes relevant. Quite
simply, we need to develop a credible growth strategy. This
need seems to be realised by the Treasury, hence the
Chancellor’s hints of a ‘£50 billion investment boost’.
One such strategy would be to create a British Investment
Bank. The first session will look at the rationale for such an
institution. This is not, of course, a new idea, but the current
economic situation has given it a renewed urgency. A British
Investment Bank could achieve two goals simultaneously: it
could improve the long-term growth prospects of the British
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economy and at the same time offset the contractionary effects
of fiscal consolidation on aggregate demand. Some would
concede that such an institution would fill a gap in the capital
market but deny that it could do anything to boost demand in
the short-term. My own view is that there is no contradiction
between the two arguments. Of course, it will take time to get
the long-term investment programme going. But a substantial
start can be made over the next five years, providing the will to
accelerate is there. And one should not underestimate the effect
on confidence of a simple announcement of an expansionary
programme.
To turn to today’s position: the government is constantly
exhorting the banks to increase their lending – even as it
proposes to burden them with increased capital requirements.
The truth is that the banking sector is paralysed by a lack of
confidence, which means that sound investments go unfunded
while bank reserves pile up. Banks are busy repairing their
balance sheets, and borrowers cannot overcome the barrier of
the high interest rates which result. Bank loan approvals to
SMEs have fallen by over a quarter since 2007, and the stock of
lending has shrunk by £5bn over the last year. A BIB could, as
much by example as by action, help clear the blockage in the
financial system.
Apart from the short term problem of demand deficiency, there
are at least three gaps which the private sector is seemingly
unable to fill on its own: first, the ‘Macmillan’ gap, a funding
problem for SMEs, first identified in the 1930s; second, the
deficiency of investment in infrastructure. According to the
Institute of Directors it will require £500bn over the next decade
to rectify the infrastructure gap. Finally, there is ‘green
investment’. A Green Bank with a promised capital of £3bn
already exists. But it is not yet operational, and it will not be
allowed to borrow until the government’s deficit is liquidated.
But it could be the nucleus of something more ambitious.
The second session will deal with the theory and practice of
national development banks, using examples from abroad. We
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need to tackle head on the common Anglo-American view that
‘government can’t pick winners’. The quick answer is that
governments can pick winners, and the private sector can pick
losers. State investment banks have been successful elsewhere
(and in fact in the past, in the UK), and we can learn from these
experiences. Take, as one example, Germany’s KfW, which has
nurtured the German Mittelstand of companies since the late
1940s without additional injections of capital. Or the European
and Nordic Investment Banks, from whom we will hear. The
theory that capital allocation should always be left to the
markets is valid only under ideal conditions. In the world of
second bests we must compare what publicly-directed
investment might do with what the private capital market
actually achieves.
In fact, the financial sector has repeatedly demonstrated a
crippling short-termism. There is evidence that the time horizon
of investment has become ever shorter. It is now increasingly
difficult to distinguish between investment and speculation. A
national investment bank that took investment decisions on
long views and on the basis of the general social advantage
would be a strong corrective to the relentless concentration on
maximising short-term shareholder value.
Our final session will consider the practicalities of a British
Investment Bank. If the idea is to be taken seriously, we must
think about how to mobilise investment without adding to the
deficit. We can take it as a given that the government will not
break its own fiscal rules. So how will the BIB finances relate to
the public finances? Here we can look at the various models
which operate around the world. Will we need a new
institution? The government already owns banks. Could these
be re-purposed to public ends? Perhaps the most basic question
– what will it invest in? And how can we make it an attractive
alternative to bonds for institutional investors? Overcoming the
private sector’s preference for liquidity, their reluctance to
invest in anything which carries a greater risk than gilts, will be
a key aim. To whom will the BIB be accountable, and how will
it be governed? What planning hurdles might potential
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investments face? These are the key practical questions which
need to be resolved.
In conclusion, let me emphasise one thing: the British
Investment Bank is one of a number of possible vehicles to reignite growth. It can be run in conjunction with other policies,
and other institutions. The overriding aim is to develop a
growth strategy, not to insist dogmatically that there is only one
way to do it.
Robert Skidelsky
London
2 November 2011
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1
Rationale for a British
Investment Bank
A mismatch between private financial returns and social
economic returns has resulted in a lack of funding for projects
of long-term value to the economy. Sectors particularly affected
include R&D, communication and utilities networks,
‘greening’, and transport infrastructure where the risks
typically associated with the scale and time horizon of these
projects as well the inability of private investors to internalise
fully the returns of their investments lead to suboptimal levels
of output.
But not only large investment projects suffer from market
failures; being too small is also a problem. The difficulty for
small and medium-sized enterprises (SMEs) to obtain funding
was officially recognised in 1931 with the identification of the
‘Macmillan Gap’. Currently, the gap is located between
approximately £250,000 where personal savings and seed
money no longer are enough and £1 million where institutional
investors become interested. Lack of economies of scale in the
administration of loans to SMEs and start-ups is a primary
reason for banks’ lack of interest in lending to smaller actors.
These are instances of supply-side failures: socially profitable
projects are not supplied with the necessary credit to take off.
The present crisis has added to this problem in two ways.
First, pressure on commercial banks to repair their balance
sheets in combination with heightened levels of uncertainty has
reduced bank lending even to projects which previously did not
suffer from credit-supply problems. But more importantly, the
crisis has brought about a chronic shortage of private sector
9
confidence. This is a demand-side problem. Households’ and
companies’ gloomy views of the future have killed demand for
investments even at very low capital costs since the yield
prospects of investments are deemed to be too low. This has in
turned resulted in a collapse of consumption as households
struggle to rebuild their net worth in the face of diminished
asset bases, which has led to less spending, more job cuts, less
demand and, therefore, to a further deterioration in confidence.
Conventionally, both supply-side market failures and
insufficient private demand are arguments for government
intervention. By committing public funds to universities and
infrastructure the government overcomes the shortage of
funding for such projects; by giving tax credits and loan
guarantees to SMEs the government reduces the failures of the
credit markets for SMEs; and in both cases, increased economic
activity increases aggregate demand which in turn boosts
private-sector confidence. However, the current Government’s
political commitment to fiscal contraction has effectively ruled
out any such stimulus of the economy.
Establishing a British Investment Bank (BIB) offers an
innovative solution to both (1) long-term failures in the supply
of credit and (2) the more short-term lack of aggregate demand.
Given the appropriate institutional structure and mandate
(discussed below), the BIB could contribute to infrastructure
and R&D investments as well as SME growth by providing
attractive finance on the basis of social economic returns in
addition to more narrowly construed private financial returns.
By providing policy stability, signalling confidence in the
project and serving as a focal point for project preparation
activity the Bank would stimulate demand amongst potential
private infrastructure sponsors. The Bank’s objective in SME
finance would be to improve the intermediation of private
sector savings to SMEs via the capital markets – for example by
co-ordinating the securitisation of SME loans – as well as via
commercial bank lending – for example via guarantees. And it
could do so with minimal impact on public finances by
borrowing money from the private sector against a limited
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public subscription capital – thus reducing the political cost of
increasing effective demand.
The short and long-term rationales for a national investment
bank should not be considered in isolation. In both theory and
practice, the two functions are closely interlinked. In theory, it
is possible to argue that deflated aggregate demand is the
consequence of a decades-long trend of growing income
inequality which has resulted in a structural lack of mass
consumption power. Solutions to the ‘short-term’ problem,
therefore, must be compatible with a long-term objective of
reversing inequality. In practice, the Bank will need to leverage
its long-term credibility to offer short-term ‘additionalities’ and
attract private capital.
In summary: there is a twofold rationale for a national
investment bank:
1.In the short term it would boost aggregate demand
2.In the long term it would contribute to the structural
reform of the UK economy
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2
Contemporary Examples of
Public Investment Banks
The idea of a public investment bank is not new. After the
Second World War, a number of multilateral and national
development banks were founded. Multilateral investment
banks included the World Bank, the European Investment
Bank, the Nordic Investment Bank, the European Bank for
Reconstruction and Development, and the Asian Development
Bank. National investment banks included Germany’s KfW, the
Japanese Development Bank, the Korean Development Bank,
and the BNDES of Brazil. Common to most of them was a
return to an investment bank model prevailing in Germany in
the late 19th century: offer long term credit and provide
technical assistance – sometimes in exchange for an equity stake
in the project supported.
Together with the KfW, the Nordic Investment Bank (NIB)
and the European Investment Bank (EIB) are the most
relevant benchmarks for how a British Investment Bank could
operate. It is therefore helpful to study these examples before
sketching institutional and operational outlines in a British
context.
The Nordic Investment Bank
Background and mandate
The Nordic Investment Bank (NIB) was set up in 1975 by the
five Nordic countries: Sweden, Norway, Denmark, Iceland and
Finland. In 2005, the group was joined by the three Baltic states:
Estonia, Latvia and Lithuania. The idea was to set up an
institution which could promote the integration of the Nordic
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economies which at the time were separated by tight regulation
of capital markets and the need for authority approval on crossborder transactions. Simultaneously, the Nordic economies
were suffering from the oil crisis and there was a general
perception that the countries would benefit from an institution
with strong credit worthiness with which to access international
capital markets more cheaply.
While the NIB’s mandate has changed since its founding, the
overall setup of the Bank as a mandate-driven institution has
not. In other words, the objective of the institution is to optimise
its mandate delivery and not necessarily to maximise the
financial yield on its assets. Today the mandate is twofold:
1. To promote the competitiveness of the member state
economies
2. To promote a better natural environment
Bank structure
The institutional structure of the NIB conforms to the design of
a number of multilateral investment and development banks.
At the helm, the NIB is governed by the Board of Governors
made up of the Finance Ministers of the member countries who
typically meet once a year to discuss high-level policy aspects
and approve the annual report. The Control Committee which
is made up of member-state parliamentarians is the Bank's
supervisory body which ensures that the Bank is carrying out
its mandated objectives. The Board of Directors makes policy
decisions concerning the operations and approves the financial
transactions proposed by NIB's President. In contrast to the
design of many other multilateral banks, this is not an in-house
board but a board comprised of member state representatives
selected by the respective governments that comes together
when necessary. NIB's President is responsible for the conduct
of the current operations of the Bank and is assisted by the
Management Committee, the Credit Committee, the Finance
Committee and the ICT Council.
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Identifying projects
While the twofold mandate set the framework for the NIB’s
activities, the institution nonetheless operates as a bank; it is not
an institution for the distribution of public money. An in-house
origination team sources potential projects in the markets and
assesses every loan according to an internal ranking system in
reference to the mandate. Only projects at the top of the scale
are accepted. By implication, the NIB rejects a substantial part
of funding applications. No one has the right to NIB funding.
In the delivery of its mandate, the NIB is a politically
independent organisation with significant institutional
integrity; there is no political steering of individual loans. The
NIB is a bank and not an instrument of government policy. It is
not uncommon that the Bank rejects applications for funding
of member-state government initiatives if it cannot be shown
that the project furthers the mandate. However, to ensure
compatibility with national industrial policies, on the Board,
representatives of the member states have the right to veto loans
targeted for his or her respective state.
In addition to evaluating projects on their own merits, the
Bank takes the state of the economic cycle into account when
determining the size of its portfolio. By holding back in economic
upswings, the Bank is able to lend in recessions when other
creditors typically mend their balance sheets. While limited in
volume, this counter-cyclical behaviour is intended to strengthen
competitiveness of the member state economies and so
contribute to the execution of the first part of the NIB’s mandate.
Areas of operation
The mandate necessarily skews the NIB’s investment to
concentrate on a limited number of core sectors:
1.
2.
3.
4.
Energy
Environment
Transport and logistics infrastructure, and telecommunications
Innovation and R&D
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The NIB is also involved in SME financing but recognises that
its institutional structure with an international hub without
local branches is less than ideal for getting to know the business
seeking finance. SME financing, therefore, is conducted through
intermediaries. Typically, this is done through so-called loan
programmes which establish credit lines to local banks with
instructions for the use of that money attached. Instructions
could, for instance, include using the money to target lending
to energy-efficiency schemes. The loans are often given with
longer maturities than the SMEs could otherwise access.
Track record
Despite its limited size, the NIB enjoys a AAA rating. With an
upper leverage limit of 2.5 times subscription capital – of which
only 6% has been paid in – the Bank has approximately €20
billion worth of loans on its books. Nonetheless, over the last
35 years, the NIB has experienced steady growth. Average
returns have been in excess of returns on government paper
over the same period. While there have been a number of
injections of capital into the Bank by the member states since its
inception, these have always been motivated by a desire to
sustain the growth of the bank – never to offset losses.
Uniquely among multilateral banks globally, the NIB pays
dividends to its shareholders. While the economic rationale for
dividends could be discussed, these annual payments have
imposed considerable financial discipline on the institution.
With a high-quality loan portfolio, credit losses over the years
have been very low compared to other banking institutions.
The European Investment Bank
Background and objectives
The European Investment Bank (EIB) is the long-term credit
institution of the European Union. It was established in 1958,
at the inception of the European Economic Community. Its
shareholders are all the member states of the EU.
The mission of the EIB is to promote EU priority objectives
through investments. It does so in three ways: first, it helps
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complete the financial plan of investment projects by providing
longer-term capital than is available from commercial lenders;
second, it acts as a catalyst for other sources of finance; and third, it
makes the project financial plan more sustainable by lowering costs
to co-sponsoring borrowers. While private investors might be
reluctant to support financially viable projects because of perception
of risk, the EIB is in a position to evaluate the projects against its
mandated objectives in addition to mere financial returns.
There are three objectives:
1. To promote growth and employment potential
2. To promote economic and social cohesion
3. To further environmental sustainability
Bank structure
The governing-body structure is similar to that of the NIB. The
EIB Board of Governors consists of the EU Finance Ministers
who set the policy guidelines. And just like the NIB, the EIB has
a Board of Directors. Peculiar to the EIB is the Management
Committee – this is a permanent executive body, responsible
for the day-to-day running of EIB. The Committee is made up
of the President of the EIB and eight Vice Presidents who are
nominated by member countries. Finally, an Audit Committee,
an independent control body, reports directly to the Board of
Governors on the financial and operational status of the Bank.
Operations and project identification
The EIB’s AAA-rating is supported by a strong capital base and
the quality of its loan portfolio. The quality is maintained through
a rigorous appraisal where all projects must contribute towards
at least one of the policy objectives. In addition, they also have to
be technically, economically, financially, environmentally and
socially viable as well as conform to procurement regulation. As
a professional and politically independent body, the project
identification process does not take fiscal policy objectives of
member states governments into account.
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The EIB issues bonds to finance its operations. Despite the lack
of sovereign guarantee EIB bonds enjoy a AAA-rating and since
the EIB is one of the largest non sovereign bond issuers globally
the bonds can be issued at low cost and with very long
maturities. As a non-profit institution, the interest that the EIB
charges its debtors is merely set to cover cost of funds,
operating costs, and to ensure a contribution towards the Bank’s
financial reserves. In this way, the EIB passes on its low-cost
financing to its borrowers.
Areas of operation
Working towards economic and social cohesion in the EU, the EIB
provide loans to all major sectors in less advanced regions or
countries to help them catch up with the EU average. Just like the
NIB, the EIB support SMEs through credit lines to commercial
banks. In addition, as majority shareholder in the European
Investment Fund (EIF), the EIB offers venture-capital guarantees.
The EIB provides funding to projects that mitigate
greenhouse gas emissions, and projects that improve
adaptation to climate change impacts. Further, the EIB gives out
loans for research and development, education, training, and
innovation to promote a more innovative and knowledge based
European economy; the EIB finance the ‘TENs’ (Trans European
Networks) supporting the integration of transport and energy
infrastructure across the EU. And finally, the EIB invests in the
diversification and security of internal energy supply.
While not formally integrated into objectives, the EIB’s
lending tends to follow a de facto counter-cyclical pattern –
providing finance when commercial lending is weak. In the
wake of the 2008 crisis, the EIB stepped up its lending
significantly. In 2008, the EIB gave out €58 billion in new loans;
in 2009, the equivalent figure was €79 billion. Although these
are large figures for an individual institution, they are not large
enough to plug the funding gap on a European level.
Across all these areas, the EIB offers technical assistance
based on experience accumulated over 50 years in addition to
financial assistance. Some of the technical assistance schemes
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are financed by the European Commission budget. For instance,
the European PPP Expertise Centre (EPEC) was recently
launched jointly by the EIB and the European Commission to
support PPP types of projects – particularly in the Trans
European Networks.
Track record
The EIB subscribed capital is €232 billion, of which €40 billion
is paid-in. Just as in the case of the NIB, the maximum leverage
ratio is 2.5. At the end of 2010, the balance sheet was 420 billion.
This makes it the largest multilateral investment bank globally.
€72 billion worth of new loans were signed in 2010 of which
approximately 90% went to projects in the European Union. The
profit in 2010 was € 2.1 billion. The EIB has enjoyed profits in
every single year since its establishment.
Role in the euro crisis
While the EIB supports the discussions between the European
Commission, the European Banking Authority and the ECB
with technical expertise regarding the development of term
funding solutions for the banking sector, the EIB does not
provide any kind of financial support to the recapitalisation or
guarantee schemes. In line with other multilateral lending
institutions, the EIB has not been asked to take a haircut on the
Greece bailout scheme.
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Lessons learned from the Nordic and European
Investment Banks
1. A public investment bank must be able to demonstrate that
it is providing additionality – i.e. that it is offering services
that would not otherwise be provided by private institutions.
The private sector’s inability to offer long-term loans and
project stability single out these services as particularly
important functions for a Bank. In addition, the involvement
of a Bank typically means that cost of capital for private cosponsors is reduced; the Bank serves as catalyst for
investments. With a few exceptions, neither the NIB nor the
EIB finance more than 50% of any given project. By imposing
such limits they ensure project-ownership participation and,
when applicable, involvement of other lenders. It is not
uncommon that the NIB and the EIB co-finance projects
together when long-term money is needed and the private
sector is not there to provide it.
2. A public investment bank should mobilise capital from
international capital markets. This requires high portfolio
quality and an adequate capital structure for the bank.
a. The quality of the portfolio depends on maintaining
sound banking principles.
b. Adequate capital structure depends on maintaining an
active relationship with the shareholders. In order to be able
to borrow cheaply against total and not just paid-in capital,
markets have to trust the fact that the shareholders indeed
are ready to honour their callable capital commitments. In
the absence of an explicit government guarantee, credibility
is based on a track record of repeated capital increases.
3. A public investment bank should not fund projects which the
private sector has rejected on the basis of poor quality. Sound
banking principles are essential and this requires political
independence in the execution of the mandate in order to
avoid political steering of individual project decisions.
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3
Blueprint for a British
Investment Bank
The experiences of the NIB and the EIB provide natural
starting points from which to attempt a sketch of the blueprint
of a British Investment Bank. What are the institutional and
operational characteristics necessary to fill the three functions
discussed earlier? Are there existing institutions which –
suitably reformed – could fill these functions or is a new
organisation required?
Mandate
In order to stimulate the economy without weighing on the
Government’s books it is essential that a British Investment
Bank is capable of attracting dormant private capital. The
experiences of the NIB and the EIB in this context point to the
importance of a politically independent organisation backed by
sovereign capital. A mandate-driven institution with
governmental or parliamentary involvement at the strategic
level and full autonomy on an operational level has proven to
be a model which successfully marries the need for public
control over public capital with the need for the maintenance
of sound banking principles for market credibility. This is the
most likely setup for a British Investment Bank.
There are good reasons to argue that the Bank mandate
should mimic the EIB’s policy objectives: (1) to promote growth
and employment potential; (2) to promote economic and social
cohesion; and (3) to further environmental sustainability. The
first of these is essential for both the short and long-term
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functions of the Bank. With considerable regional differences
within the UK, the second objective could reasonably be
considered integral to the promotion of national competitiveness.
The third has political traction as a long-term necessity.
While this three-legged mandate is wide, it should not be
mistaken to be all-encompassing. The Bank should not be
everything to everyone; offering additionalities is key. The Bank
would execute its mandate by means of offering funding and
technical expertise to projects that furthered its policy objectives
– funding unavailable through conventional commercial
channels. However close the economy is to full capacity, the
emphasis on mitigating market failures would minimise the risk
of crowding out private actors. The present situation with huge
under employed and unemployed resources reduces this risk
even further.
Operations
Similar to its peers, the British Investment Bank’s mandate
suggests a focus on long-term productive assets and
employment potential in the areas of infrastructure and SMEs.
In both of these the Bank’s operations can be divided into
financing operations and advisory.
Infrastructure financing
In the current climate where few private institutions are willing
to commit to the risks inherent in the early stages of developing
large-scale projects but where there is considerable pressure
among institutional investors to source existing projects with
predictable yields, the Bank’s infrastructure involvement can be
characterised as an inverted form of the Private Finance
Initiative (PFI). Instead of the private sector raising expensive
capital to build assets which it then leases to the public sector,
the public sector raises cheap capital to build assets which it then
refinances into the private sector. By providing such ‘confidence
bridge’ loans or guarantees in the early stages of project
development the BIB would ensure that investments with the
potential to improve the long-term prospects of durable,
21
resource-efficient growth of the British economy such as
improved facilities for energy and transportation and highspeed internet proceed beyond the drawing board – investments
that the private sector is keen to finance at a later stage.
Infrastructure advisory
The Bank would play a crucial role as the Government’s centre
for project identification, preparation, appraisal and evaluation.
This advisory function is core to the Bank’s ability to catalyse
private co-investment and stimulate aggregate demand.
It ensures that a supply of credit is met by a pipeline of
prospects. It is also possible that the bank would have the
capacity to offer advisory, structuring, and distribution of
private infrastructure financing. The Bank’s effectiveness would
be greatly aided by a simplification of current planning
procedures so that projects that have the necessary backing do
not get delayed by red tape. The importance of coordinating
policies of infrastructure investment and an overhaul of the
planning process cannot be overstated.
SME financing
Without a network of local loan offices, the Bank’s SME funding
would follow the model of the NIB and the EIB and take
the form of extending credit lines to local commercial banks
to strengthen their SME lending. By taking on the risk of
lending to SMEs the BIB could prevent leakages of credit
intended for SMEs. It is also possible to envisage close
cooperation between the Bank and the recently established
Business Growth Fund – the £2.5 billion equity fund set up as a
result of discussions between commercial banks and the
Government on how to strengthen SMEs. The division of labour
between the Bank and the Fund could be modelled on that
between the EIB and the EIF.
SME advisory
On top of its financing activities, the Bank could be responsible
for the securitisation of existing stocks or new flows of SME
22
loans. This is an advisory, structuring, and distribution activity
and does therefore not require risk absorption capacity.
Ensuring that the Bank securitises only the lending of
commercial banks and not its own SME lending would avoid a
conflict of interest between the need for the securitising entity
to scrutinise the quality of the lending entity’s loans.
Any aspiration by the Bank to conduct counter-cyclical
lending would have to be balanced against its zeal to offer only
what the private sector could not. The conventional requirement
of finding local co-financing partners risks reducing lending in
economic downturns since the appetite and ability of local
partners to take on risk are reduced. If, however, the Bank
relaxes its co-financing standards in recessions it will inevitably
be difficult to justify its lending as purely additive. It would step
in to replace private lenders.
Political independence vs. policy link
An issue that needs careful consideration concerns the balance
between, on the one hand, the need for operational
independence and, on the other, the importance of maintaining
a strategic link with government policy. The importance of the
former in terms of establishing credibility in the markets and
achieving financial sustainability has already been discussed.
However, in terms of the Bank’s ability to stimulate aggregate
demand the latter is no less important.
Government policy creates or kills markets. As a result, the
long-term credibility of the Bank both in terms of its borrowing
and its credit origination relies on the belief that there will be a
policy environment which will continue to address market
failures. The degree to which the BIB can leverage funds for
green policies depends on there being a credible policy for
carbon pricing, standards and regulations; the degree to which
the Bank can leverage private money into broadband networks
depends on the existence of a recognised policy to roll out
broadband networks into the medium term. Private confidence
in the viability of large-scale infrastructure and energy
investments is to a large extent determined by the length and
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visibility of a pipeline of public projects and policies. Without
credible policy commitment by the Government, the Bank
might find itself pushing on a string in the search for investable
projects. There simply would not be enough demand to absorb
available funds.
And the problem with insufficient demand for investments
is pervasive among SMEs too. Current high levels of
uncertainty make it difficult for many companies to identify
projects with sufficiently high returns to warrant taking a loan.
Also here policy is key. Not only can large-scale infrastructure
projects be expected to stimulate demand for firms local to the
area of construction such as restaurants and private hire cars,
but policy can be directly targeted to creating SME markets. For
instance, if the government were to withhold housing benefits
from landlords that fail to upgrade their properties according
to some minimum standard, it would establish a huge market
for local construction businesses.
Interestingly, the Bank itself offers a potential solution to the
tension of ensuring political autonomy while needing policy
support. It is not unlikely that government ownership of the
Bank could serve as a commitment mechanism for policy. That
is, if the government has a stake in the Bank’s performance it
will be less liable to abort policies supporting BIB lending. The
value of any implicit government guarantee on BIB bonds
would rise if government policy were to negatively impact the
BIB’s loan book. Insofar as the government marked such
guarantees to market in its accounts, it would show a loss. This
would serve as a commitment mechanism for maintaining a
consistent industrial policy across parliaments.
Capital and funding
Regardless of the institutional structure and areas of operations,
there remains the question of how to fund the Bank’s
establishment. There are two ways in which the Government
could finance the subscription capital: it could issue gilts to be
bought by the markets and/or the Bank of England; and it could
use the profits from selling its equity in commercial banks such
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as RBS and Lloyds. The choice between these two is a primarily
a question of the treatment in the national accounts. This issue
is inconsequential in terms of the functioning of the Bank, but
its resolution is nonetheless of vital importance considering the
political pressure to reduce the deficit and stabilise the public
debt level. If the Bank is perceived to worsen public finances it
will never be established.
If the Government were to opt for the first alternative – i.e.
to capitalise the Bank out of its budget for capital spending by
means of issuing new loans – the deficit would increase relative
to the current baseline in the year of capitalisation by an amount
corresponding to the new Bank subscription capital. The public
debt would increase by this amount. If the Government were
to opt for the second alternative – i.e. to capitalise the Bank out
of the profit from equity sales – the impact on the budget would
be less clear. In effect it would constitute an asset swap and as
such it would be neutral for the public debt since the debt and
deficits to purchase the original shares have already been
incurred. So as to jump start the establishment of the Bank, one
idea is to treat the recently established but under-sized Green
Bank as the institutional embryo of the BIB. In this case, either
of the above capitalisation options would come on top of the
existing appropriation for the capitalisation of the Green Bank
which is factored into the Government's existing fiscal and
public finance projections.
Lending activities would be funded by issuing long-term
bonds to private investors. BIB bonds would not be covered by
an explicit government guarantee; instead it is the public
ownership and the quality of the credit portfolio that would
vouch for the institution’s credibility. In an economy crippled
by uncertainty and with substantial pools of un-invested
savings, BIB bonds would offer an attractive option to investors:
they would be less risky than corporate bonds while offering a
yield higher than that of government gilts. Historically low gilt
yields and the ability of even private sector companies to access
the bond market at negative real yields constitute strong
evidence of the capacity and desire of private savings to fund
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long-term, highly credit-worthy, well diversified portfolios.
Care would be taken to pass on the Bank’s cheap capital costs
to its borrowers, but the Bank would aspire to make a modest
financial profit from its operations for the purpose of
accumulating reserves.
Given the Government’s postulated majority stake in the
Bank, under current rules BIB borrowing would be registered
as liability in the public accounts. This, in turn, would increase
deficit projections. A solution to this political problem is to
make use of comprehensive balance-sheet accounting that
appropriately scores increases in net worth in the Bank’s assets.
A national investment bank would never fund current
expenditure; it would finance investment in productive assets
that generate long-term returns. Although BIB borrowing
would show up in the Government books it would be financed
by revenue from its own activities. This type of borrowing is
qualitatively different from tax-financed debt.
Other implementation issues
Setting up a new financial institution with large enough a
balance sheet will require parliamentary process and budget
appropriations. Building on the existing Green Bank framework
is an intuitive way of speeding up this process. In addition, it
makes sense to allow for a two-tiered process whereby the
advisory business side for both infrastructure and SMEs which
does not require a balance sheet is launched ahead of the slower
moving financing business. Similar to existing public
investment and development banks, the British Investment
Bank could start its advisory operations with a high-quality
skeleton staff of sectoral experts, with most of the technical
work contracted out to the private sector as well as relying on
existing expertise from the various government departments
such as the Department of Transport, the Environment, Energy,
Regions and the BIS.
Simply increasing contributions to the EIB to allow it to fill
the functions envisaged for the BIB is not practical from the
point of view of UK policy freedom viz. eurozone. This is
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particularly important in terms of the BIB’s ability to serve as a
policy commitment mechanism.
A further aspect of Government commitment pertains to the
Bank as an institution in addition to its operations. The
privatisation of the Industrial and Commercial Finance
Corporation (ICFC) and its transformation into 3i shows how
changing governments’ changing policies risk bereaving the
Bank of its original functions. With the rationales for a public
investment bank intact, such an evolution would necessitate the
foundation of another public Bank at a later stage. Possible ways
of reducing the risk of privatisation include inviting a greater
number of shareholders – which could all be public institutions
– and/or designing a federal institutional structure.
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4
Conclusion
With mandates to promote competitiveness, growth and
environmental sustainability, the Nordic and European
Investment Banks have for decades leveraged relatively small
amounts of public capital in the private markets to strengthen
lending to infrastructure and SMEs. Enjoying complete
operational autonomy, the Banks assess each project in terms
of its long-term return – economic as well as financial. The
Banks are not investing in projects rejected by the private sector
because of poor quality but finance activities that the private
sector has rejected because of inability to fund. Neither bank
has ever had to exercise its right to capital replenishment to
offset losses; both banks have consistently registered profits.
With low risk appetite among lenders and crippled
confidence among borrowers, the British economy is inundated
with dormant private capital. At the same time, UK
infrastructure and SMEs need investment to sustain standards
and contribute to growth and employment. Following
the example of its Nordic and European peers, a British
Investment Bank could step in and clear this blockage in the
financial system.
In combination with simplified planning procedures, the
Bank could stimulate demand by boosting private-sector
confidence in both policy commitment and project viability. This
is particularly important to set the economy on a path to
recovery in the short run. But there are good reasons to establish
the Bank also for the long run. SMEs have suffered from the
Macmillan funding gap for at least 80 years; and also in good
times infrastructure projects struggle to find tail-end finance.
And in addition to financing, a British Investment Bank would
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play an important role as a centre for project identification,
preparation, appraisal and evaluation.
To avoid a second recession, the UK economy is in desperate
need of a growth plan. A British Investment Bank is not the only
way to growth but it offers a solution both to the insufficient
supply of, and the insufficient demand for, credit without
burdening public finances significantly. After the failures of
Plans A and B, a British Investment Bank is a concrete proposal
for Plan C.
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Participants at the British Investment Bank conference,
Westminster, 2 November 2011
Andrew Johnson (EEF – Manufacturers’ Association)
Chi Lo (HFT Fund)
Cormac Hollingsworth (for Gordon Brown MP)
Crispin Williams (Association for Consultancy and
Engineering)
Darryl Murphy (KPMG Infrastructure)
David Merlin-Jones (Civitas)
Dmitri Zenghelis (LSE)
Felix Martin (Thames River Capital)
George Irvin (SOAS)
Gerald Holtham (Cadwyn Capital)
Gerard Lyons (Standard Chartered)
Giles Wilkes (for Vince Cable MP)
Gonzalo Ramos (former EBRD)
Daniel Ottolenghi (European Investment Bank)
Ha-Joon Chang (University of Cambridge)
Harro Pitkänen (Nordic Investment Bank)
Jeff Masters and Harry Holdstock (for Chuka Umunna MP)
Jo Johnson MP
John Weeks (SOAS)
Karl Richter (Jen Li Foundation)
Kitty Ussher (former Treasury minister)
Larry Elliott (Guardian)
Lord Liddle (Policy Network)
Louis Mosley (for Rory Stewart MP)
Marilyne Tolle and Tomas Hellebrandt (Bank of England)
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Michael Burke (former Citibank)
Norman Price (Chair, West Midlands Enterprise Board)
Tim Armstrong (Dept for Business, Industry and Skills)
Centre for Global Studies
Robert Skidelsky
Christian Westerlind Wigstrom
Pete Mills
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